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Selling Toll Roads in Indiana

Testimony to Indiana Senate Appropriations Committee

Geoffrey Segal
February 9, 2006

Mr. Chairman, members of the committee, thank you for allowing me to speak with you today. My name is Geoffrey Segal; I am the director of government reform at Reason Foundation, a Los Angeles-based non-profit think tank that has researched and analyzed public-private partnerships and transportation policy for more than 35 years.

What is a PPP?

Simply put, a public-private partnership is a contractual arrangement under which the private sector carries out some or all of a function traditionally done by the public sector. When looking at the types of transportation partnerships we're really talking about three arrangements.

First, the outsourcing of highway maintenance, design, or other services. This is quite popular and has a tremendous track record in saving states millions of dollars.

Second, is the lease of an existing toll road or facility. Note, however, that ownership remains with the state. You're not giving up ownership if you're getting it back at some point.

Finally, the third type of highway partnership is allowing the private sector to develop and operate new toll roads.

Just so we are on the same page, it's important to note that public-private partnerships are a type of privatization. Over the years, the term privatization has grown into an umbrella term that covers many situations. While Major Moves invites more private-sector participation, by no means is it true privatization where the state divests itself of its role of ownership or oversight.

Transportation has a long and deep history of private sector involvement. Indeed, it dates back to the beginning of road construction and operation in the United States. Many of the earliest major roads in the United States were private toll roads—in fact, there were more than 2,000 private toll roads in operation in the 19th century. As the country moved westward the need for roads grew, and private turnpike companies responded to the needs of a growing country. They constructed essential highways that were operated as toll roads.

Over time, private involvement has declined as states and the federal government increased the pace of road construction. However, financing and construction have not kept pace with demand. In the late 1980s some states began exploring the potential for the private sector to augment highway construction programs.

Major toll bridges, using a concession model, in San Francisco and Detroit marked a reemergence of sorts in the late 20th century. Private sector participation has certainly enjoyed a revival, sparked by federal legislation in1991 that established a new vision for transportation. For the first time, private entities were allowed to own toll facilities. Two initial projects in Virginia with the Dulles Greenway and California with the 91 Express Lanes marked a new frontier, and an initial wave of enabling legislation was passed in states like Arizona, Florida, Minnesota and Washington. However, there were few projects.

As federal and state highway funding has become more constrained, and as the need for highly efficient transportation systems continues to grow, the role of the private sector has continued to grow. Most recently a second wave of more workable laws, allowing long-term concessions has hit the states. At least 20 states currently have these laws in place, and at least a half-dozen states, including here in Indiana, are currently reviewing or considering similar legislation. However, only those with the right provisions are favorable for private investment. That's why Major Moves is important: it has already proven to contain vital components to attract private sector capital.

Since ISTEA was passed in 1991, we've seen tremendous growth and reliance on toll roads. A recent survey from the Federal Highway Administration notes that 922 miles of new toll roads were opened or are under construction. An additional 1,989 miles are currently in the finance, design, or planning process. These assets carry a total value of $79 billion. With new technology making collecting tolls much easier and more efficient, we can expect more growth.

Four key developments are driving the most recent tolling revolution:

First, HOT lanes or managed lanes. The success of I-15 and SR-91 in California demonstrate that value pricing works. It does eliminate congestion on priced lanes, and gets the other "free" lanes moving faster too.

Several HOV conversions to HOT are currently underway in California, Colorado, Minnesota and Texas. My home state of Virginia is also studying, and hopefully rolling out soon, similar conversions on I-95 and the capital beltway.

In addition, several new HOT lanes are proposed, mostly as PPP projects in Atlanta, Dallas, Denver, San Antonio, and Washington, DC.

Second, the lease of Existing Toll Roads. Since 1999, there have been six major global leases of existing toll roads. Note, these are all long-term leases, not sales. Those are:

Clearly, our European friends have been at this a little longer than we have here in the United States. While many of the toll roads started as state-owned, they have slowly but consistently taken on private partners over the years.

However, the United States is catching up quickly. Besides the Indiana Toll Road there is significant domestic activity currently underway:

So does a long-term lease make sense? If nothing else, these efforts bring in substantial flows of capital that can be used to invest in other areas, and can be further leveraged utilizing the partnership model.

Beyond the obvious, what other fiscal considerations ought you to make? First let's look at the return on assets. Looking to the lease of the Chicago Skyway, the city was netting a profit of $8.4 million on an asset value now known to be $1.8 billion, or 0.5% ROI. Meanwhile the city was paying 5 percent on its own debt—12 times the rate they were getting by running the Skyway. Clearly they're better off with the cash.

The New Jersey Turnpike generates a net profit of $115 million, with a potential asset value of $10–20 billion. This ROI is a little better at 0.6, or 1.1%. – Again, the debt payments are six times the rate of return.

Looking specifically here in Indiana, several different figures were given here today referring to operating profits. Either way, assuming there was a slight operating profit, the state is generating an ROI that is similar, if not less, than both Chicago and New Jersey, with a known asset value of $3.85 billion, not to mention the capital shortfalls that already plague operations. In addition, the amount of interest the state will earn needs to be brought into the equation. Instead of paying out money, the state will be generating it.

Second what should you do with the proceeds? They should be spent on transportation projects, identified by INDOT as strategic and important opportunities to link the state, modernize its highway infrastructure, and maintain and strengthen Indiana's claim as the "Crossroads of America."

Next let's examine what it means for the state's transportation policy. For starters, better customer service. Electronic toll collection will be rolled out saving commuters time and relieving them of the hassle of searching for change. The ETC rollout of the Chicago Skyway was done in record time, less than six months. There's no reason to believe that similar speed and efficacy wouldn't take place here in Indiana. In addition, private toll operators have first-rate programs to assist broken down customers. They have also developed customer guarantees if the road fails to meet expectations or save time as the pioneered by the 91 Express Lanes in California. In addition, the toll road can and should be operated as a real business. Cost cutting measures are put in place and quality is the highest priority.

Private concessionaires also tend to make better investment decisions and have greater access to capital. The Indiana Toll Road hasn't seen a rate increase for 20 years as politics were put ahead of the condition of the road or the need for expansion. The western end of ITR requires millions of dollars in investment just to reach INDOT standards; a concessionaire would not wait for fear of losing customers.

A third consideration is why to use global companies. While in the process of forming, there currently are not any viable U.S. firms in the business of owning and operating toll roads. As I mentioned earlier, foreign countries have a lot more experience than we do. It makes sense that they would have more expertise. As well, they have a track record with which to evaluate their practices. A vital asset like the Indiana toll road demands experienced management. With that said, at least 90 percent of the work can be furnished by Indiana companies.

The third key development is the concession model for new toll roads, following a long-term ownership interest. Examples abound, including the following:

As Commissioner Sharp noted, there is some $50B in proposed private sector investment right now, either for leasing of existing toll roads or the development of new ones. It's worth noting that the federal government spent $34 billion on transportation last year. Either way, the 20 to 25 billion dollars is a huge amount of money. That's being driven into just five states.

The way we finance roads is changing. Traditional means, federal and gas taxes, are limited and increasingly failing to meet the challenges and needs of commuters. Even traditional tolling, which relies on tax-exempt bonds is falling short. The concession model—using equity, bank debt, and taxable revenue bonds—is quickly becoming the model for getting the roads we need. It's less risky for start-up toll roads since they're not entirely funded with debt, but it also opens up a much larger source of funding. There are literally trillions of dollars in pension funds and insurance companies starting to invest in U.S. infrastructure. Major Moves is a shift toward innovative financing that will deliver the roads Hoosiers need faster, cheaper, and without new taxes.

This new model also transfers risk. The state is totally protected because all of the money is paid upfront. If there are cost overruns and/or inadequate revenues, the contractor is on the hook for any losses, not the state. Additionally, the concession agreement is very detailed and protects the public interest. It has defined the limits on tolling and ROI. It has spelled out all kinds of "what-ifs." Performance levels are well-defined and the contractor is required to meet them or face penalty.

Incentives also change with operation. The contractor has all the incentive to keep the roads running efficiently and effectively. If there is a need to expand, they do it quickly so that revenues can begin to accrue. Quality also has to be top priority.

Wrapping up

Tolling and public-private partnerships offer some major advantages. First, it brings a large new net investment in the transportation system—in this case, $3.85 billion. Second, it puts new capacity in place many years sooner, getting I-69 financed and built, along with countless other projects that will be funded with Major Moves. Citizens will be able to reap the benefits sooner. Third, it brings higher quality highways to better serve customers. Finally, it shifts risks from taxpayers to investors.

The key to success is a detailed long-term PPP agreement that protects both parties. The concession agreement does just that. At over 400 pages it includes rich detail, explicit performance measures, and penalty for failure to meet expectations.

There is no shortage of funds to invest in better highways. Global capital is already flowing into California, Georgia, Texas, and Virginia—and soon into others.

Indiana is at a crossroads. It can choose to open its doors to this capital and a new way of doing business, or not. If not, other states will reap the benefits.



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